What is Quota Share Treaty
A quota share treaty is a pro rata reinsurance contract in which the insurer and reinsurer share premiums and losses according to a fixed percentage. Quota share reinsurance allows an insurer to retain some risk and premium, while sharing the rest with an insurer up to a predetermined maximum coverage.
BREAKING DOWN Quota Share Treaty
When an insurance company underwrites a new policy, it is paid a premium by the policyholder, and in exchange, it agrees to indemnify the policyholder up to the coverage limit. The more policies that an insurer underwrites, the more its liabilities will grow, and at some point, it will run out of capacity to underwrite any new policies. In order to free up capacity, the insurer can cede some of its liabilities to a reinsurer through a reinsurance treaty. In exchange for taking on an insurer’s liabilities, the reinsurer receives a portion of the policy premiums.
A quota share treaty is a reinsurance agreement in which the insurer cedes a portion of its risks and premiums up to a maximum dollar limit. Losses above this limit are the responsibility of the insurer, though the insurer can use an excess of loss reinsurance agreement to cover losses that exceed the maximum per policy coverage.
Some quota share treaties also include per-occurrence limits that restrict the amount of losses that a reinsurer is willing to share on a per-occurrence basis. Insurers are less willing to accept this type of agreement because it can lead to a situation in which the insurer is responsible for most of the losses stemming from a particular occurrence of a peril, such as a catastrophic flood.
How Quota Share Treaties Work
As an example, consider an insurance company looking to reduce its exposure to the liabilities it has created through its underwriting activities. It enters into a quota share reinsurance contract. The contract has the insurance company retaining 40 percent of its premiums, losses, and coverage limits, but ceding the remaining 60 percent to a reinsurer. This treaty would be called a 60 percent quota share treaty, because the reinsurer is taking on 60 percent of the insurer’s liabilities.
A quota share treaty reduces financial exposure to adverse claim fluctuations. The cedent can continue to participate in the underwriting gains in some negotiated percentage, even though it has reinsured the business, and it has access to outside expertise from a professional reinsurer. Think of a quota share treaty as giving away a part of an insurer’s retention. In return, the insurer gets to increase its acceptance capacity with automatic cover.